T + 0 Possible?
Jonathan M Hazell
The stock market used to settle trades in one day. It was not uncommon for the settlement to occur overnight. (1) These type of transactions happened through the 1930's. Couriers rushed certificates around the streets of New York and other trading centers to make these trades. The sheer volume of paper forced the markets to adopt new standards. The settlement time officially increased eventually to 5 days in 1968 and stayed that way until 1995, when it went to 3 days. (2) Technology and communications have obviously gone through a complete change in the last 20 years. The heightened Internet relay speeds and leaps in computer processing power still have not increased the settlement time. In September of 2017, the settlement time is actually scheduled to lower to 2 days. (3)
The change to T + 2 (Trade + Two days) creates an immense amount of volume of guidelines and changes for the industry. (4) The finance industry's desire to reduce the actual trade time has led it to take a hard look at the Blockchain as a new type of settlement facilitator. (5) The challenge for the financial industry is that the Blockchain was created as a decentralized system of settlement between two parties. Blockchain was created as the protocol for Bitcoin currency transactions. The trust element is one of the key issues involving a Bitcoin transaction. A purchase in real time at the location using Bitcoin simply needs to go through the Blockchain process of verification, which currently takes approximately 7 minutes. A blind exchange between parties, like buying furniture from an online ad, involves an entire other level of trust. The seller of the furniture will receive the Bitcoin payment almost immediately. The buyer then has to rely on trust that the seller will ship the furniture. This trust element contrasts to a fiat payment through a bank or credit card. The buyer receives a short duration to stop payment from the bank. A third party is involved. The payment is a real time settlement, but the funds are escrowed by the bank for a short period, (1-2 days) allowing for the stoppage of funds if a problem occurs, such as a non-delivery of service.
In the securities world, a merger of the current financial industry settlement model and the Blockchain will inevitably involve a third party, which negates the decentralization feature. The stock is no different than the furniture. It is not being purchased at the location in real time. That stock has to be delivered for the payment of the Bitcoin. The third party has to guarantee the stock exists and the trade is executed. The use of tokens, colored coins, smart contracts, etc, to represent the securities and oracles, which are programmed agents delivering real time data such as instant market changes are offered as a solution. (6) The securities though still are held elsewhere. Some type of conversion still has to be made. The challenge with this is, as recently discussed, " When it comes down to it, It still is simply moving Bitcoins around the Blockchain." (7)
The other issue involving securities involves the market rate. How do Blockchain facilitated trades happen, when the speed of trading well surpasses the inherit Blockchain settlement rate? The financial industry currently spends upward to $250 billion a year in IT and operations costs. (8) The uniform transition needed for mass adoption of Blockchain-oriented will be incredibly costly. The cost advantages of reducing down settlement time are acknowledged by most in the industry. Centralization appears to be inevitable. Are there options?
One option appears to be the creation of an entirely separate market structure, an Alternative Trading System, (ATS). Patrick Byrne the CEO of Overstock.com, the online retailer, and a pioneering figure in the Bitcoin world, appears to be trying to do exactly that. T0 is the world's first platform to offer a company's bonds and stock on the Blockchain itself. (9) The stated objective is the allowance of direct trade between customers and the company. This cuts out the middle agents and the resulting fees and costs. This platform appears to address the decentralization issue. No counterparty is needed to make the transaction. This is an exciting development. It however, at this juncture, does not offer an investor other choices. The company is working on attracting other companies to use its ATS platform. It has partnered with a broker/dealer firm, Keystone Capital Corporation to attract more companies. (10) The broker/dealer's role in this ATS differs than the traditional exchange model. It does not facilitate the technological elements of the trade. The Blockchain platform itself automatically takes care of this. It makes the exchange. The broker/dealer role turns more to setting up digital wallets for clients and signing the transactions. The trade itself is not "handled". This means less time in settlement. This is a fundamental shift in the exchange system. T0's name derives directly from the ability to make instantaneous transactions, T + 0.
Byrne's T0 platform may be as close as comes to decentralized security trading. There are still many steps ahead and at this point, T0 really only services Overstock.com. A fundamental shift will have to occur in order for an entire industry adopt an ATS such as this one or any other system. It costs the current system $250 billion in yearly operational costs. That is a lot of investment. The system was able to shift from couriers and piles of papers into its current computerized form. The industry leaders though did not lose control of the system. The use of the Blockchain is different. The costs will be much lower, but potentially so are the rewards...at least for the trade facilitators.
The question here is this a "Too Big to Fail" issue? The Blockchain is tied to digital currency. Will the established Central Banking system and world trade platforms actually allow any ATS based on the Blockchain to grow and thrive? News reports surface daily about traditional platforms, such as central banks, etc. adopting the Blockchain or replicating its function. The challenge of course, is that the Blockchain was created in opposition to centralizing platforms. The current system has a lot at stake to perpetuate its survival. There remains concern that the Internet itself will be further centralized and controlled. This can take many forms; outright elimination of certain sites and functions, data packet prioritization, etc. Perhaps innovators like Byrne should also focus on networking systems that are not reliant totally on the Internet itself, such as mesh networks. Future essays will cover this topic. It is perhaps a foundational issue that is not often understood and addressed.